Stay Out of Credit Card Debt

REDBOOK financial guru David Bach tells you how to get a handle on your own fiscal situation and our troubled global economy.

"I just dug myself out of credit card debt and want the cards out of my life. Is it smart to cancel them?"

Congratulations on paying off your debt! And of course it's a priority to stay out of debt. Getting rid of the temptation to spend by closing your accounts may seem like the logical thing to do. But by closing out your accounts, you'll actually lower your credit (FICO) score which determines whether a bank will lend you money and at what interest rate. A low FICO score can really put a wrench in your financial plans, so getting rid of credit card accounts altogether is not a smart solution: Using cards responsibly is necessary to build a solid credit history.

Why does canceling your credit cards lower your score? Because your credit score takes into account what's called a credit-utilization ratio, which compares your total credit used against your total credit available. The higher the ratio is i.e., the more of your available credit you're using the more negatively it can affect your credit score. So when you close a credit card account, you are decreasing your total available credit, which then increases your credit-utilization ratio. Confused? There's an excellent example of how this works at myfico.com. Click on Credit Education, then go to the Q&A section and scroll down to "Will closing a credit card account help my FICO score?"

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